Tuesday, May 9, 2017

2. The Formation of Capital

One of the
conundrums of a modern economy is how to restore Say’s Law of Markets so that
consumption and production are in balance.What makes the problem worse is the fact that the mainstream schools of
economics, Keynesian, Monetarist/Chicago, and Austrian, take for granted an
assumption that flies directly in the face of Adam Smith’s first principle of
economics stated in The Wealth of Nations:
“Consumption is the sole end and purpose of all production.”

Irving Fisher (1867-1947)

While this point
seems obvious, most modern economics assumes as a given that production is only
partly for consumption.They think the
purpose of production is also to accumulate excess production that is saved in
order to finance new capital formation.The bottom line is that, in modern economics, the purpose of production
is consumption and more production.

Producing for
both consumption and reinvestment for more production throws a monkey wrench
into the economic machine.Dr. Harold G.
Moulton explained why when he analyzed Dr. Irving Fisher’s formulation of the
Quantity Theory of Money equation,

M x V =
P x Q

where M is the money supply, V is
the “velocity” of money (the average number of times a unit of money is spent
during a period), P is the price level, and Q is the number of transactions.

It seems that
Fisher made a few mistakes in trying to apply his own formula.First and foremost, Fisher assumed that
“money” referred only to currency and “currency substitutes” such as checks,
credit cards, and debit cards (the latter two didn’t exist in Fisher’s day, but
even he would agree that they are used in lieu of cash).

As Moulton
pointed out, the money supply consists of anything that can be accepted in
settlement of a debt.Not accounting for
the bulk of the money supply means that decisions affecting monetary and fiscal
policy are going to be based on very bad data, and will almost inevitably be
wrong.

Another point
Moulton made was that Fisher’s analysis included only consumer goods in the
number of transactions, distorting the results even more.Moulton explained that, as far as the
producer of a good or service is concerned, all sales are “consumption.”The producer of a capital good is indifferent
regarding the use to which a purchaser puts the product.It’s all
consumption to the producer, even if it is an investment in future production
by the purchaser.

John Maynard Keynes (1883-1946)

Deliberately
producing more than can be consumed at current levels of income in order to
generate savings — and then artificially creating demand by issuing government
debt in order to clear the goods and transfer purchasing power (generate
savings) from consumers to producers by inflating the price level is, as far as
Moulton was concerned, the height of insanity.Yet, even though some authorities regard Fisher as the founder of the
Monetarist/Chicago school of economics, and John Maynard Keynes of (obviously)
the Keynesian school of economics, their respective solutions to the Great
Depression were curiously similar: inflate the currency to raise the price
level and generate savings.

What necessarily
happens under the past savings assumption is that overproduction, from being a
temporary problem caused by a lack of purchasing power in an economy in which
Say’s Law is functioning, becomes a way of life:

·To generate savings to finance new capital
formation,

·Producers produce more than can be sold at
current levels of demand,

·Causing goods to pile up unsold,

·Creating a downturn in the economy,

·Workers are laid off in response to insufficient
demand,

·The rate of new capital formation declines,

·Causing demand to drop further,

·Government issues debt-backed money to stimulate
the economy,

·Artificially raising the price level,

·Transferring purchasing power from consumers to
producers,

·Which generates savings,

·Which are invested in new capital formation,

·Creating new jobs,

·Which produce more than can be sold at current
levels of demand to generate additional savings,

·Starting the cycle all over again.

Unfortunately,
because the effects of the Keynesian “countercyclical approach” are cumulative,

Tyrannosaurus Debt (1776-DATE)

·The price level tends to go up as a matter of
course,

·Deflation is viewed the same as a decline in the
price level whether caused by a restriction in the money supply, decrease in
demand, or currency appreciation,

·Government debt grows exponentially in both
inflated and real terms in a self-defeating effort to clear market gluts and
create jobs,

·Leading to more government debt to bail out
bankrupt consumers and producers either directly or by allowing debt repayment
with inflated currency.

The only real
solution to such a bizarre situation — considered normal under the past savings
assumption — is to put consumption and production back together, i.e., restore
Say’s Law of Markets.In an economy in
which capital is far more productive than labor, that means only one thing:
people must own both labor and capital to be productive, and link productive
power to consumptive power once again.